MC Exclusive: “Early success blindsides you”: Saurabh Mukherjea on mistakes, lessons learnt, and favourite Indian investors

A: The unchanging pieces are clear. First, heavy-duty forensics — using both quantitative and qualitative research to avoid the rogues. In any stock market, 30–40% of companies will flatter numbers to juice up share prices and then raise capital.

Second, among the cleaner companies, focus on those with strong franchises. We measure a franchise simply: ROCE and long-term return on capital above cost of capital. That remains the basic test of quality.

What changed in 2022–23 was threefold.

First, we realized that consistent compounders by definition deliver 15% profit growth, maybe 20% in good years. If such a stock doubles in 12–18 months, the share price is running far ahead of profits. A reversion to mean is almost certain. You can either sit tight through that correction — but when you’re managing large sums and clients enter at the top, the drawdowns become very painful.

Take Divi’s Labs. It soared during Covid on Molnupiravir profits, and we trimmed our position as the pandemic ended. But we didn’t cut enough. By Jan 2022 the company said Covid was over, and in 9–10 months the stock halved. Our clients bore that pain. That taught us: either stop taking new money when portfolios are euphoric, or re-size positions so late entrants don’t face the worst of the drawdowns.

Second, we had to do this methodically. That’s when our Global Compounders team suggested we size positions not by expected earnings growth alone, but by expected IRR. For example, if EPS growth is 20% but you believe the PE multiple will halve over five years, you subtract ~8% and assume a 12% return. That naturally reduces position size and incorporates valuation mean reversion.

By mid-2023, we implemented this IRR-based sizing.

Third, to make this work we had to broaden coverage. Instead of tracking 60–70 names, we expanded to 130–140 through 2022–24. A wave of IPOs helped. Wider coverage meant we could trim overheated stocks and still have fresh options.

These are lessons no book can teach. We started in 2018, and in three years had ₹5,000 crore flowing in. It was a bewildering experience. Only in hindsight did we grasp how early success blindsides you. That was our biggest challenge — not the market, but the consequences of our own success.

The good news is, we’re wiser. Performance has improved since applying IRR discipline. Our Global Compounders portfolio has compounded ~26–27% in rupee terms net of fees. MeritorQ, our quant strategy, is up ~17–17.5%, ahead of benchmark. Little Champs and Rising Giants, which were crushed in 2021–22, have bounced back. Kings of Capital — after a rough patch when PSU banks ran — is recovering. Even Consistent Compounders has improved, though we think IRR discipline can be applied more aggressively there.

Q: It takes courage to admit early success blindsided you.

A: It’s incumbent on us. In this business, the better the performance, the more faith people place in you. That’s precisely when you need to be careful about taking money and deploying it. You can either stop accepting inflows when performance is hot, or keep taking money but cut down position sizes in the stocks that have delivered the most. In hindsight, we should have done more of the latter. We do now.

Q: But is this only about position sizing? What about your approach to valuations in general? You used to say you could disregard PE if the company was great.

A: For individual investors, the Coffee Can approach still works best. Let quality companies run. Timing is near impossible. Take Divi’s again: stellar until Covid, then supercharged, then halved in 2022, then doubled again post-2023. If you’d sold at the Covid peak, you’d likely never have bought back. Individuals without armies of analysts are better off staying invested and letting time work.

For professionals like us, it’s different. When a stock soars, inflows pour in and we’re forced to deploy at stretched valuations. When mean reversion hits, new investors get hurt. Hence our IRR approach.

Q: So for individuals, valuations can be ignored if the business is strong?

A: Unless you’re a valuation expert, yes. Most investors have jobs and limited time. It’s unrealistic to track multiples daily, speak to analysts, and time entries and exits. That’s why Coffee Can investing, as Rob Kirby argued in 1984, remains the best bet for retail investors. Otherwise, you risk selling after a 50% drawdown and missing the next 10x run.

Q: But do historic valuations matter to you? Do you benchmark against them?

A: Yes, with caveats. We use three comparisons. Let’s take the example of Trent:

Index: If Nifty trades at 15–17x and a stock is at 120x, it’s clearly overheated.

Sector: If retail trades at 40–50x and Trent is at 120x, it signals potential pullback.

Company history: If Trent historically traded 50–60x and is now 120x, that’s another marker.

Using these, we estimate fair value and then adjust expected returns. For instance, if Trent at 120x should mean revert to 60–70x, we’d shave 8% off projected EPS growth of 25%, arriving at ~17% expected return — our position sizing anchor.

But this has limits. Take Titan. For 20 years, its “steady-state PE” has drifted up. Many dismissed it as just gold retail, but Titan kept improving supply chains, working capital, and made a stellar CaratLane acquisition. It became a fundamentally better business, justifying higher multiples. That’s the hard part: recognizing when a company today is meaningfully stronger than a decade ago.

Q: And how do you judge that?

A: We’re still refining our methods. A simple starting point: track rolling five-year ROCEs. If they consistently drift up, something’s working. That’s often your best clue that the company is creating real, compounding value.

Q: Fair enough. Now give me three examples of stocks which have taught you the maximum.

A: As I explained earlier, sometimes the biggest lessons come from the same company going up, down, and up again. Thankfully, in the last couple of years we managed to catch the upside.

Take HDFC Bank. The learning there was like the Ferrari versus one-litre engine analogy. If someone had told me back in 2018, when we set up the firm, that we would have a portfolio of HDFC Bank, Divis Labs, Dr. Lal Path Labs, Asian Paints — all top-class franchises — with earnings growth in double digits, and yet see the portfolio fall 15% in just 15 months, I would have said nahi ho sakta. But we lived through it.

Back in 2022, there wasn’t an earnings problem with any of these names. Earnings growth was mid-teens. We would sit in the office wondering: “Earnings growth is good, so why is the portfolio going backwards?” The answer was reversion to mean. In the five years through 2021, our portfolio compounded at 25% annually while the market did 18%, on the back of earnings growth of 17–18%. That was well above fair expectation. Life has now taught us that you need to anticipate mean reversion, adjust for it, and factor it in. That was a big lesson.

Q: One stock that taught you the hardest lesson?

The hardest learning, though, was Relaxo. During Covid, people were at home buying slippers, and we thought demand would sustain. After all, a Relaxo chappal is an essential product. But when oil prices rose post-Covid, Relaxo hiked prices sharply. Their entry-level chappal that sold at ₹85 during Covid jumped to ₹150–160 within a year. That’s when the company lost leadership to the informal sector.

The unorganised players make chappals by melting milk packets, costing just ₹50–60. If Relaxo was at ₹80, customers would choose the organised brand. But when the price moved to ₹150 and the alternative stayed at ₹60, the market shifted away.

It was shocking because here was a company that had made great corporate decisions for decades, creating 100x shareholder returns over 20 years. Yet one strategic misstep cost them dearly — and cost us as well. Even now, two-and-a-half years after we sold, they haven’t regained their mojo. And this is footwear — there’s been no massive structural change in the market. To see a franchise that dominated for 10–15 years regress like this was one of the most painful but valuable learnings.

Q: Anything else which taught you a specific investment lesson?

A: Yes. In small caps, especially specialty chemicals, we had a huge run during Covid. Between 2019 and 2021, our Little Champs portfolio doubled in three years, powered by specialty chemicals and related ancillaries. But once Covid ended, Chinese supply came back and China started dumping into global markets. Those same companies that looked like structural compounders suddenly looked cyclical.

The mistake was taking three years of unusual data — when global trade was frozen — and extrapolating it as structural strength. The lesson was to take a much longer view in assessing businesses, otherwise you risk confusing temporary tailwinds for long-term trends. Post-Covid, Little Champs suffered as those specialty chemical bets failed.

Q: Would you extend this learning to your earlier point — that as a private investor, if you find a great company, you should just sit it out? What about commodities or cyclical plays?

A: The bigger point is this: everything is cyclical. Even hawai chappals are cyclical. Paint is cyclical. Blood tests at Dr. Lal Path Labs are cyclical. In 2023, it hit us that cycles exist everywhere — even where the data doesn’t scream it.

For steel or real estate, cycles are obvious. But in diagnostics, paint, footwear, the cycles are more subtle. As investors, we now consciously try to identify cycles where others believe none exist, and invest accordingly.

Take banking today. NPAs are rising, liabilities are hard to raise — a great environment for HDFC Bank. For a few quarters, it will enjoy a hammerlock on low-cost liabilities and could push ROEs toward 20%. But eventually, as conditions ease, competition for deposits will return, and HDFC Bank’s edge will erode. That second- and third-step thinking wasn’t well developed for us during Covid. We’re better at it now.

Q: The last two years have been difficult for you on account of both performance and considerable redemptions. How has this period been for you personally? How have you coped?

A: It’s one thing to read about cycles before starting a business, another to live through them. You hear people say if you can’t stomach a 50% drawdown, you shouldn’t be an investor. But when you actually go through it, you realize it’s about holding mind and body together while the world calls you a loser.

At the same time, you have to cut noise and focus: What did we do right? What did we do wrong? What can we fix? Mistakes are part of investing. The key is to minimize them and not repeat the same ones.

It’s also a privilege. Markets and clients both give you feedback constantly. If you can’t take it, this isn’t the right job. But if you can, you separate signal from noise. For example, some said Coffee Can or quality investing was dead in India. That was noise. The signal was to refine our process, learn, and keep managing money for those who trust us.

We’ve been lucky with supportive clients. The Indian Navy officers’ pension fund, which we manage, has been a source of pride. They’ve stood by us, given constructive feedback, and handled volatility with equanimity. Institutional clients abroad have also been steady. And many Indian families who entrusted us with life savings stayed invested through tough times.

Personally, I enjoy this part. It keeps you alive, forces you to learn every day, and gives you the chance to be a little better than yesterday. My colleagues are even better at this mindset than I am. Going through cycles as a team has been enriching.

Q: Are there investors in India you admire and have learned from?

A: Absolutely. We’ve known Pulak Prasad of Nalanda for years — back in my brokerage days, I helped with block deals for him. Over time, my admiration for him and his team has grown. His book on what evolution teaches us about investing was epic; everyone in our office read it three times over. It became like a Bible.

Another is Sankaran Naren of ICICI Prudential. I first wrote about him in Gurus of Chaos 15 years ago. Since then, I’ve had the chance to learn from him as a broker and later as a fellow market participant. Watching him navigate cycles over 30 years has been rewarding.

During Covid, he repeatedly warned me about valuations, pointing to historical periods when expensive stocks corrected. I argued that Covid was so unusual that history wasn’t comparable. In the end, Naren was right. Especially in small caps, we’ve tried to apply many of his lessons.

Watch his full interview on The Wealth Formula podcast with N Mahalakshmi here:

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